Spain's Bonds Fall With Italy's as Rally Fades Before Fed Meets

  • Decline extends volatile month for euro-zone government debt
  • Lucidus Capital liquidating holdings adds to market `jitters'

European bonds fell, retracing last week’s advance, as investors erred on the side of caution before the Federal Reserve’s final policy meeting of 2015.

Adding to the market’s anxiety was the news Monday that high-yield credit fund Lucidus Capital Partners had liquidated its entire portfolio. Spanish and Italian securities led the declines, after the biggest weekly slide in European 10-year bond yields in at least a month. Spain’s two-year note yield jumped to the highest since early October.

While the U.S. central bank is widely expected to raise interest rates on Dec. 16, the main focus of the gathering will be Fed Chair Janet Yellen’s speech, where investors will search for clues on the pace of future policy tightening.

“Positioning and year-end issues are definitely playing a part,” said Owen Callan, a Dublin-based fixed-income strategist at Cantor Fitzgerald LP. “Jitters” over high-yield funds, together with “continued problems in the energy sector, may just be seeing people offload positions across the board given what’s coming up from the Fed, and then the holiday season kicking in.”

Yields on Germany’s 10-year bund, the euro area’s benchmark government debt, rose three basis points, or 0.03 percentage point, to 0.57 percent as of 5 p.m. London time. The 1 percent security due in August 2025 dropped 0.33, or 3.30 euros per 1,000-euro ($1,104) face amount, to 103.99. The yield fell 14 basis points last week, the most since the period through Oct. 2.

Draghi Effect

European Central Bank President Mario Draghi may also have contributed to the increase in yields. He said he expects current stimulus measures will be enough to return euro-zone inflation to policy makers’ target, while reiterating that officials stand ready to do more if needed.

European bonds have had a choppy month. French and German securities suffered their worst drop since June in the week ended Dec. 4 after the ECB’s monetary easing measures fell short of some investors’ expectations. They then rallied last week amid speculation the initial reaction was overdone.

Ten-year Spanish bond yields surged 10 basis points on Monday to 1.73 percent, and the nation’s two-year note yield rose three basis points to 0.09 percent, having climbed to 0.11 percent, the highest since Oct. 5. The 10-year Italian bond yield also added 10 basis points to 1.64 percent.

Funds Junked

The liquidation of Lucidus Capital’s $900 million of credit funds signals that the carnage in the high-yield market is worsening. A $788.5 million mutual fund run by Third Avenue Management LLC and a $400 million hedge fund managed by Stone Lion Capital Partners LP stopped returning cash to investors last week after clients tried to pull too much money.

Now attention turns to the Fed. There’s a 78 percent chance the U.S. central bank will raise its record-low benchmark rate by a quarter-percentage point this week, according to futures prices compiled by Bloomberg. The calculation is based on the assumption the effective federal funds rate will average 0.375 percent after liftoff, compared with the current range of zero to 0.25 percent.

“Last week we had a strong rally” in euro-zone debt, said Daniel Lenz, lead market strategist at DZ Bank AG in Frankfurt. This “definitely had an influence on this counter movement,” he said.

“It’s more about profit-taking,” said Lenz. “Investors may stay sidelined and remain cautious. A rate hike is being priced-in. The question is more, ‘What will the Fed do next?’”

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